The Role of Audit Quality and Corporate Governance in Reducing Earnings Management

Abstract

This study aims at investigating the role that the factors associated with audit quality and corporate governance play in reducing earnings management practices in the Jordanian industrial and service companies listed in Amman Stock Exchange. In order to achieve this aim, the financial data of a sample of 92 companies during the period (2011-2014) was reviewed. Earnings management is measured based on the absolute value of discretionary accruals according to the modified Jones model (1995). As for the independent variables, the effect of audit quality is measured through auditor size –big 4, auditor opinion, audit report lag, audit fees and auditor change, while the factors associated with corporate governance are measured through board of directors characteristics and ownership structure. In order to answer the study questions and test its hypotheses, a number of statistical methods were employed, such as pooled data regression using "E-views" software. After analyzing the data, the study revealed a number of results, including the existence of earnings management practices in all Jordanian industrial and service companies under study during the study period (2011-2014). Furthermore, the results indicated that there is a statistically significant negative effect for the auditor size –big 4 in terms of auditor opinion on reducing the practices of earnings management for our study sample. With respect to audit report lag and auditor change, there is a statistically significant positive effect on reducing the practices of earnings management for the study sample. The study revealed that there is a positive effect, but not statistically significant, of board size on reducing the practices of earnings management for the study sample. At the same time, it was demonstrated that there is a negative effect, but not statistically significant, for board independence and CEO duality on earnings management. The study also revealed a statistically significant negative effect related to the percentage of managerial ownership and concentration ratio on earnings management practices. Based on the study results, the researchers recommended the regulatory bodies represented by the Securities and Exchange Commission to force companies to submit their financial reports within the period stipulated by law and to impose legal penalties on the violating companies. They also recommended that legislators and regulators issue a law that requires continuous inspection of licensed auditing offices to verify their compliance with professional laws and standards.